Let's face it, the current historic reporting framework used by companies, is by itself, inadequate for investors and other stakeholders to understand a companys true value. Whilst the historic reporting framework still has a place in the financial world by providing reasonable consistency in corporate reporting, it fails to measure the true value of companies. Historical financial indicators do not reflect a companys capacity to grow, adapt and change.
In a knowledge-based economy, a new reporting framework is needed to allow businesses to communicate more effectively on intangibles such as brand reputation, customer retention, intellectual capital, product development pipelines, reliability of deliveries and employee turnover. The current reporting framework based on past financial performance is now living on borrowed time and is arguably outdated in terms of the demands of todays economy.
Investors who typically base share price valuations on the prospects for future cash flows are now requiring forward-looking and non-financial information to feed into their valuation models. While earnings, revenue growth and other financial measures are important indicators of current performance, in the current economy, other measures often non-financial in nature increasingly are viewed with equal, if not greater, importance. It is therefore not surprising that the real story of companies is not being communicated to the market, giving rise to a widespread belief that share prices do not reflect the true position.
Management is in a difficult position; on the one hand, there is an understandable reluctance to reveal corporate "secrets" which would be of value to competitors; while on the other hand, in this new world, management may simply be unaware of what the markets would be interested in.
In essence, therefore, we are dealing with a reporting 'gap' that has two facets. Firstly, from the markets perspective, there is an information gap: companies are not reporting what the markets want. Secondly, from the corporate perspective, management is aware that there is a gap to be filled, but is unable or unwilling to move away from traditional reporting methods and content.
This situation is made more complicated by the growing view that a 'one size fits all' model will simply not suffice. The information requirements of the markets differ considerably from one industry to another. Therefore industry-specific models will likely emerge and evolve over time.
In overview, the gap is caused by a discernible shift in the markets valuation method from one which was founded in historical, financial information, to one which more resembles a balanced scorecard approach. Such an approach takes into account lead indicators which include:
- Market share (linked to customer retention and satisfaction)
- Quality (of products and processes)
- Human capital (Employees are our most valued asset)
- Intangible assets (the growing gap between a companys net assets and its market value)
This shift is understandable; accounting was formerly oriented around an industrialized economy, built on tangible assets with a bank of historical information and a focus on the stewardship of assets. But today, accounting is seeking to adapt to a technology-based economy driven by intellectual and human capital. The markets are demanding information that helps them look forward, not backwards, more frequently and more quickly.
Astute analysts and investors recognize that they can get a better view of what a company is doing to enhance future performance and build value from information concerning areas such as new product development, customer growth, consumer satisfaction and loyalty, brand development and employee training and turnover than from current financial results.
While companies may not always have this information readily available, such measures increasingly are being used in internal performance measurement systems through balanced scorecards, business driver analysis, and other management reporting systems. PricewaterhouseCoopers has undertaken detailed global surveys regarding the information needs of analysts, institutional investors and venture capitalists in several industry sectors. The message is strong and remarkably consistent: analysts and investors want broader information on companies than what the short-term financial results alone typically provide.
However, until a standardized method of reporting value is developed and agreed upon, the traditional reporting model has an important role to play in helping to standardize frameworks for disclosing information. The most progressive companies appreciate that the fundamentals, on which successful business has always depended, remain as valid in the new economy as they do in the old. The traditional reporting framework should not be discarded, just used as a foundation for an enhanced reporting framework designed around the needs of the markets and investors in 2001 and beyond.
Companies that are unwilling to entertain greater transparency are likely to fall victim to the increased volatility that the capital markets are already experiencing. Whereas those that are proactive in communicating the value of their business in the ways that the market demand, have a better chance of managing their market capitalization and achieving their long-term value growth goals.
The benefits of developing a new set of value measures are substantial. Internally they will have a far-reaching impact on the development of strategy, the evaluation of the achievement of goals and on executives' compensation. On the market, they will generate higher management credibility, an increased number of long-term investors and higher shareholder value.
Peering into the future, what is certain, is that companies will be increasingly required to facilitate quick access to both financial and non-financial information through innovative reporting.
Partner, Assurance & Business Advisory Services, PricewaterhouseCoopers
Email: [email protected]